Dan Walters: Pensions back on the agenda in Stockton’s bankruptcy

From the onset of Stockton’s journey through bankruptcy, Judge Christopher Klein has implied, both through comments and rulings, that he sees it as a potential test of whether public employee pensions are debts that could be reduced.

The city didn’t seek pension modification in its bankruptcy petition, although some creditors and their insurers did, and the California Public Employees’ Pension System intervened, contending that pension liabilities are exempt from bankruptcy proceedings.

Eventually, the city worked out debt-reduction deals with all but one of its major creditors, Franklin Templeton Investments, which rejected a settlement it said would repay less than 1 percent of the $37 million it’s owed, and again raised the issue of pension debt.

That rejection prevented Stockton from presenting a signed-and-sealed plan to Klein, generating a trial this week and a comment from the judge indicating that the pension issue is still an unresolved issue.

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“We have a festering sore here,” Klein said. “We’ve got to get in there and excise it and figure out what the story is. Maybe CalPERS is correct, maybe not.” He later summoned CalPERS officials to testify on the issue.

It was not the first time that Klein had indicated that pensions may not be, as CalPERS contends, shielded from “impairment.”

The CalPERS position rests largely on a section of the state constitution barring impairment of contracts, but Klein, in a past ruling, warned that those provisions may not be a barrier.

Ruling in a preliminary matter, he said, “bankruptcy is nothing but the impairment of contracts.”

Meanwhile, as Stockton was trying to work out deals with its creditors, and failing with Franklin Templeton, San Bernardino filed for bankruptcy protection, with pension debts a major issue. Then Detroit dropped the big bomb, and a judge in its case ruled that pensions can be scaled back despite a Michigan constitutional provision almost identical to California’s.

Klein’s willingness to actively intervene in the Stockton case would seem to ramp up pressure on the city – and CalPERS – to offer Franklin Templeton a sweeter deal and, it might hope, remove the pension issue from the case.

However, if that doesn’t happen and Klein were to rule that Stockton’s pension obligations lack special status and are just garden variety debts that must be treated like those owed to other creditors – as he has implied he may do – the repercussions would be massive.

Coupled with what’s happening in Detroit – and what’s happened in other states – the issue might well wind up in the U.S. Supreme Court. Public pensions could lose their sacrosanct status and cities and other local governments facing financial distress could use that to compel their unions to accept pension reforms they otherwise would reject.